A Comparative Analysis of PERS, MPERS and MFRS Frameworks

A Comparative Analysis of PERS, MPERS and MFRS Frameworks By Tan Liong Tong 1. Introduction In February 2014, the MASB issued Malaysian Private Entities Reporting Standard (MPERS) and this sets a new milestone for financial reporting of private entities in Malaysia. The new reporting framework, known as the MPERS Framework, is effective for financial statements beginning on or after 1 January 2016, with early application permitted. Private entities now have a choice of continuing with the existing Private Entity Reporting Standards (PERS) Framework, or apply the Malaysian Financial Reporting Standards (MFRS) Framework (mandatory for non-private entities, except transitioning entities), or by 1 January 2016, mandatory migration to the new MPERS Framework. As the requirement for first-time adoption of MPERS is retrospective, it is important the private entities prepare in advance if they have to migrate to the MPERS Framework or the MFRS Framework in the near future. A common question that private entities would ask is how far-off or how different is the current PERS Framework when compared with the newer MPERS Framework or the MFRS Framework. This article is a comparative study that examines the differences between the MPERS Framework and the current PERS Framework used by private entities, and with the MFRS Framework used by non-private entities. MPERS is a self-contained Standard that comes with 35 sections covering all the relevant areas for financial reporting by private entities. This comparative study focuses on the issues of recognition, measurement, presentation and disclosures of the various Standards. It is a study of differences in accounting treatments among the three reporting frameworks, covering the following broad areas: (a) Presentation of Financial Statements and Accounting Policies, Estimates and Errors; (b) Business Combinations & Consolidation-Related Standards; (c) Financial Instruments; (d) Standards on Assets; (e) Standards on Liabilities; (f) Revenue and Revenue-Related Standards; and (g) All Other Standards included in MPERS. The findings of the Study indicate that it is not too onerous for private entities to make a transition to the MPERS framework. 2. The Methodology of the Study This Study identifies 38 areas of accounting for comparison between the three reporting frameworks. The areas are selected based on the topics covered in the MPERS framework and those in the PERS framework or the MFRS framework that are relevant to private entities. Thus, areas such as segment reporting, interim reporting and earnings per share which are applicable only to public listed entities are excluded from the scope of the Study. In areas where there are no equivalent PERS Standards (such as business combinations, financial instruments and related party disclosures), the comparison of PERS is based on generally accepted accounting principles (GAAPs) of any previous standards issued by the professional accountancy bodies before 1997 (such as in Agriculture) and 1

the requirements of the Companies Act 1965 (for business combinations, related party disclosures and share capital requirements). The Study first examines the detailed requirements of each section in MPERS and compares those requirements with the equivalent PERS standard and MFRS standard. In narrative description, the requirements and differences are analysed, the result of which is shown in Appendix 1 to this article. The detailed application requirements and procedures in each area are highlighted in the analysis only if there are differences between the three reporting frameworks. A paired-comparison of differences in accounting treatments is made between PERS and MPERS, PERS and MFRS, and between MPERS and MFRS. The differences in the comparison are ranked in six ascending discrete levels of differences, ranging from no differences to very high level of differences. Rank scores are assigned to each level in the ascending order of the ranking i.e. scores of 0, 1, 2, 3, 4 and 5 respectively, with a simple average rank score of 2.50. The criteria for the ranking are as follows: Levels Rank Scores Criteria No differences (N) 0 No differences in treatments Very low level (VL) 1 One difference in treatment Low level (L) 2 Two differences in treatments Medium level (M) 3 Three differences in treatments High level (H) 4 Four differences in treatments Very high level (VH) 5 Five and above differences in treatments For the purpose of this Study, treatment differences relate to differences in recognition principles (such as whether borrowing costs are capitalised or expensed and the criteria for recognising identifiable intangible assets in a business combination), in measurement principles (such as whether cost model, revaluation model or fair value model is applied for a particular asset or liability), in presentation of line items (such as whether the presentation of liability and equity instruments is in accordance with legal form or with economic substance and the offsetting presentation), differences in model or approach used in an area (such as risks and rewards approach versus rights and obligations approach, differences in control models, and reporting currency versus functional currency concepts), differences in exceptions and exemptions in Standards, and in disclosure requirements. Thus, the relative importance of a particular area is determined by the number of treatments applicable. If a particular area (such as borrowing costs) has only one treatment (whether capitalised or expensed) it can only have a maximum of very low level differences. In an area where there are only three treatments, the maximum level is a medium level in this Study. For most areas, they may be ranked with a maximum potential of five or above treatment differences. This Study uses a strict level of tolerance for differences in treatments, at intervals of one treatment difference. Differences of five or more treatments in an area are automatically considered a very high level of differences. Another basis, such as intervals of two-treatment differences with 10 differences considered as very high level, may produce a different result from this Study. The frequencies of the number of areas by levels of differences are multiplied by their respective rank scores to determine the weighted mean rank score in each paired-comparison. 3. Narrative Comparison of the three Reporting Frameworks 2

MPERS has a separate section on Concepts and Pervasive Principles, whereas for PERS and MFRS, the reference is the Conceptual Framework. There is no major difference in the Concepts and Pervasive Principles because the MASB uses the Conceptual Framework as a basis for issuing standards. There are only minor differences in the emphasis of the qualitative characteristics and pervasive principles. The MASB has retained the original Conceptual Framework for the Preparation and Presentation of Financial Statements for PERS. The MPERS framework identifies reliability as a desirable qualitative characteristic of financial statements (which is the same as in the original Conceptual Framework for PERS), whilst this has been replaced by faithful representation as one of the two fundamental qualitative characteristics in the revised Conceptual Framework for MFRS. Also, prudence is a pervasive principle in MPERS and PERS but not in MFRS. Although these are minor differences in emphasis, they nevertheless set the basis in which Standards are prescribed in the three reporting frameworks and help users understand why the MPERS framework uses more of cost-based measurement models whilst the MFRS framework prescribes fair value measurements for certain situations. 3.1 Presentation, Accounting Policies, Estimates and Errors 3.1.1 Presentation of Financial Statements There are some minor nomenclature changes to the titles used in the MPERS Framework, such as statement of financial position to replace balance sheet and statement of comprehensive income to replace income statement. MFRS requires the 3 rd statement of financial position (as at the beginning of the comparative period) to be presented whenever there is a retrospective application of a change in policy, a retrospective restatement on correction of errors, or a reclassification of line items, if the effect on that 3 rd statement is material. There is no such requirement in PERS and MPERS. Also, minority interest is deducted (or added) in the income statement in PERS whereas MPERS and MFRS prohibit debiting or crediting non-controlling interest (NCI) in profit or loss because NCI s share of profit or loss is not an expense or income item. Because NCI is equity, the statement of changes in equity must have a column to show the movements in the NCI amount. Similarly, dividend per share, which is shown on the face of the income statement in PERS, is removed in MPERS and MFRS because dividend payment is a transaction with equity holders, not an expense item. The components of other comprehensive income (OCI), which are presented within the equity statement or as a stand-alone statement in PERS, are now presented in the statement of comprehensive income in MPERS and MFRS. However, MFRS requires segregation of items of OCI into those that may be reclassified to profit or loss and those that will never be reclassified to profit or loss. The segregation of OCI items is not a requirement in PERS and MPERS. MPERS provides an option to present a simplified version of the statement of income and retained earnings in place of the statement of comprehensive income and the statement of changes in equity if the only changes in the period arise from profit or loss, dividend payments and prior period adjustments to opening retained earnings. PERS requires presentation of extraordinary items separately in profit or loss but clarifies that this can only arise in extremely rare occasions, such as due to an expropriation of assets or an earthquake or other natural disaster. Both MPERS and MFRS ban such presentation. Another major difference is the disclosure of judgements applied in the selection of accounting policies and key sources of estimation uncertainties, required by both MPERS and MFRS but not in PERS. Similarly, 3

the disclosure of capital management objectives, policies and strategies is only required in MFRS, not in PERS or MPERS. 3.1.2 Cash Flow Statements For the statement of cash flows, there are no differences of treatments between the three reporting frameworks. The minor differences in clarification and guidance are explained in the Appendix 1 to this article. 3.1.3 Accounting Policies, Estimates and Errors All the three reporting frameworks have the same requirements for the selection of accounting policies, which must be in accordance with the applicable Standards, and in the absence of Standards, the selection of policies is based on a hierarchy of authoritative guidance. Similarly, all the three reporting frameworks require a mandatory change in accounting policy if it is required by a new Standard, and permit voluntary changes only if they result in a better presentation. If the change in policy is mandated by a new Standard, all the three reporting frameworks require that the change be accounted for in accordance with the specific transitional provisions in the Standard. In the absence of specific transitional provisions and for all voluntary changes, PERS requires as the benchmark treatment, retrospective application of the new policy with restatement of comparative information. However, if the adjustment to opening retained earnings cannot be reasonably determined, the change in policy is applied prospectively. The allowed alternative for a change in policy is a current year treatment whereby the resulting adjustment is included in the determination of net profit or loss for the current period. In contrast, both MPERS and MFRS require only retrospective application, with an impracticability exemption. When the exemption is availed the adjustment is made in the earliest period practicable (which may be the beginning of the current period). The requirements for changes in accounting estimates are the same for all the three reporting frameworks. PERS uses the term fundamental error whereas MPERS and MFRS use the term prior period error. Some errors may be material but not fundamental, and would thus be outside the scope of PERS. MPERS and MFRS do not distinguish an error as fundamental or material, and is thus potentially wider in scope. Apart from this change, all the three reporting frameworks have the same requirement of retrospective restatement for correction of errors, except that PERS allows the alternative treatment of a current period adjustment, whereas MPERS and MFRS provide for an impracticability exemption. For new Standards that have been issued but are not yet effective in a current reporting period, MFRS requires disclosures of that fact and any potential effect on an impending change in policy in the future periods. There is no such requirement in PERS and MPERS. 3.2 Business Combinations and Consolidation-Related Standards 3.2.1 Business Combinations At the international level, the accounting requirements for business combinations have changed significantly over the years. PERS does not have a Standard on business combinations and the practices by private entities may have relied on generally accepted accounting principles (GAAPs) and the provisions of the Companies Act 1965 on merger relief. 4

MPERS requires application of the purchase method (also known as the acquisition method), which means that an acquirer must be identified in a business combination even if it is a merger of equals. MFRS has the same requirement for the use of the acquisition method for all business combinations within its scope. The previous practices under GAAPs used the acquisition method for most business combinations but required the merger method when the specified criteria, including the merger relief provisions of the Companies Act 1965, were met in rare occasions of merger of equals. The current practices by private entities no longer use the merger method because it is considered an out-dated method for business combinations. MPERS specifies the cost elements that form the cost of a business combination. MFRS prescribes similar measurement requirements on the consideration transferred. Generally, both MPERS and MFRS require that the consideration transferred (including contingent considerations) in a business combination should be measured at fair value, with limited exceptions. In MPERS, expenses incurred in connection with a business combination are capitalised in the cost of combination whereas MFRS requires that such expenses should be expensed to profit or loss, except for transaction costs of issuing financial instruments (equity or debt instruments) in a business combination, in which case, the transaction costs are included in the initial measurement of those financial instruments. Both MPERS and MFRS require that assets acquired and liabilities assumed (including contingent liabilities) should be measured at acquisition-date fair value, with limited exceptions. The assets acquired must include identifiable intangible assets even if these assets are not recognised in the books of the acquiree. However, the criteria for recognising identifiable intangible assets in a business combination differ among the three reporting frameworks [see the discussion in section 3.4.3 of this article on Intangible Assets]. MPERS requires that any non-controlling interest (NCI) in an acquiree should be measured at share of net assets (this is the same requirement in the old GAAPs), whereas MFRS permits a choice, on an acquisition-by-acquisition basis, to measure NCI at acquisition-date fair value or based of NCI s share of the net assets acquired. MPERS allocates the cost of combination to share of the assets acquired and liabilities assumed with the resulting balance being attributed to goodwill or gain on purchase. If the acquiree is not wholly-owned the goodwill recognised is only attributable to the acquirer. MFRS determines goodwill as the difference between: (a) the aggregate of: (i) the consideration transferred, (ii) NCI measured either at acquisition-date fair value or at share of net assets, (iii) and fair value of any previously held interest, and (b) the identifiable net assets acquired. If NCI is measured at acquisition-date fair value, the goodwill on combination would include a portion attributable to the NCI. It also means that the goodwill on combination is only calculated once i.e. at the date control is obtained, whereas the old GAAPs required that goodwill should be calculated on a step-by-step basis in a step-acquisition. MFRS further requires that any previously held interest in the acquiree must be remeasured to fair value at the acquisition date, with the resulting difference in amounts recognised as a gain or loss in profit or loss. It also requires that any previously recognised OCI gains or losses deferred in equity should be recycled to profit or loss or transferred to retained earnings in accordance with the applicable Standards. There are no such requirements in MPERS. Also, there is no requirement or guidance in MPERS on step-acquisition, increase in equity stake after the acquisition date, and reverse acquisition accounting. 5

In MPERS, goodwill is considered to have a finite useful life and hence, the subsequent measurement of goodwill is at cost less accumulated amortisation and impairment. If the useful life of goodwill cannot be estimated reliably, the life is presumed to be 10 years. In MFRS, goodwill shall not be amortised but shall be tested for impairment annually. 3.2.2 Consolidated Financial Statements Consolidation is another area which has advanced to a different level in the MFRSs. The three reporting frameworks have different requirements for consolidation. Both PERS and MPERS use a control model based on power to govern financial and operating policies so as to obtain benefits. MFRS uses a new control model based on power to direct the relevant activities and extract returns and there must be a link between power and returns. Some investees may be identified as a subsidiary under de facto control (dominant shareholder concept) or purely by virtue of an agreement to control and extract returns (e.g. control of structured entities even if the investor holds no equity interests). These newer concepts are not in the PERS, whilst MPERS only has a simplified requirement on special purpose entities (SPE), which uses risk and reward indicators to identify control. The indicators may not necessarily point to a control relationship. PERS only exempts a wholly-owned parent from presenting consolidated financial statements, whilst MPERS and MFRS allow the exemption for partially-owned parents, and for MFRS only, provided the non-controlling shareholders have been informed and do not object to the exemption. PERS requires a subsidiary to be excluded from consolidation on the grounds of temporary control and severe restrictions. MPERS exception also applies if a parent has no other subsidiaries other than the one acquired with a view to disposal, in which case, the parent applies the fair value measurement for that one subsidiary if the fair value can be measured reliably, otherwise at cost model. MFRS does not provide for exceptions on these two grounds, a subsidiary is excluded only when control is lost. However, the subsequent amendment requires that investment entities shall measure its investments in subsidiaries at fair value through profit or loss, rather than by consolidation. On disposal of a subsidiary, both PERS and MFRS require that the cumulative exchange reserve (for MFRS, including other applicable OCI reserves) of the former subsidiary must be recycled to profit or loss, but MPERS does not permit recycling of OCI reserve. Both PERS and MPERS require that for any stake retained, either as a financial asset or becomes a joint venture or an associate, the carrying amount on that date becomes the new carrying amount (either as deemed cost or deemed fair value) of that stake retained, whereas MFRS requires a remeasurement of the stake retained to its fair value on the date control is lost. PERS further deals with changes in stakes in a subsidiary, and provided the criteria of cash consideration and fair value are met, any decrease in stake is treated as a deemed disposal of interest for which the gain or loss is recognised in profit or loss. Any increase in stake is treated as a piecemeal acquisition of interest for which an additional goodwill is recognised. All other changes in stakes are treated as equity transactions with any financial effect adjusted directly in equity. MFRS uses the control criterion to differentiate the treatments. A derecognition is done only when control is lost, which means that all other changes in stakes (whether increase or decrease) that do not result in a loss of control are treated as equity transactions for which the effect is adjusted directly in equity. 6

PERS restricts the attribution of losses to NCI up to the capital contribution, meaning that there can be no debit NCI (except for guarantee situation). Both MPERS and MFRS require full attribution of profit or loss and OCI even if it results in a debit NCI. 3.2.3 Separate Financial Statements Separate financial statements are those presented by a parent or an investor with interests in joint ventures or associates, in which the investments are accounted for at cost or at fair value (or revalued amount for PERS). The three reporting frameworks do not mandate which entities should prepare separate financial statements. The presentation is by voluntary election or if it is required by local laws and regulations. In Malaysia, the Companies Act 1965 requires presentation of company financial statements, which are deemed separate financial statements if they meet the definition (implied by the 9 th Schedule s requirement for disclosure of dividend income from investments in the profit or loss of the company). Separate financial statements account for investments in subsidiaries, joint ventures and associates on the basis of the direct investments, rather than by consolidation or share of net asset changes. In the case when a parent issues consolidated financial statements, its company financial statements are deemed as separate financial statements (provided they meet the definition). The presentation applies equally to an investor with a joint venture or an associate where its financial statements (primary) must first use the equity method to account for such investments. It may then elect to prepare separate financial statements using the cost model or fair value model (or revaluation model for PERS) to account for its investments in joint ventures and associates. PERS requires a parent or an investor without a subsidiary to account for the investments in the investees at cost or at revalued amounts. The measurement model in MPERS and MFRS is an accounting policy choice by category of investments, either at cost or at fair value. MFRS has a requirement on the measurement of cost of investment when a parent establishes a new entity to be its parent in an internal group reorganisation. In such cases, the new parent, if it applies the cost method, shall measure the cost of investment at its share of carrying net assets value (equity items) of the original parent rather than at fair value. There is no such requirement in PERS or in MPERS. Interestingly, MPERS introduces (but does not require) a new set of financial statements, known as combined financial statements that were previously not in the MASB literature. Combined financial statements are a single set of financial statements that combine two or more entities under the control of a single investor. However, only a limited guidance is provided on the procedures for preparing combined financial statements. 3.2.4 Joint Arrangements Both PERS and MPERS use the form to identify the types of joint arrangements. An arrangement structured through a separate vehicle (such as a joint venture company) would automatically be classified as a jointly controlled entity. In contrast, MFRS uses the rights and obligations approach to identify the type of arrangement. A separate vehicle is not necessarily classified as a joint venture as it depends on the substance of the arrangement. For jointly controlled operations and jointly controlled assets (combined as joint operations in MFRS), the requirement in all the three reporting frameworks is to account directly for assets, liabilities, income and expenses based on rights to the assets and obligations assumed. 7

For jointly controlled entities (classified as joint ventures in MFRS), both PERS and MFRS require the equity method for measurement. MPERS, however, provides for flexibility in the choice of accounting, which may be: (a) the cost model, (b) the equity method, or (c) the fair value model. The other notable differences among the three reporting frameworks in this area are: (a) (b) (c) (d) Exception or exemption of the equity method is provided in the MFRS for investment-type entities but not in PERS or MPERS; PERS provides for exception of the equity method on the grounds of temporary investment or conditions of severe restrictions, but these exceptions have been removed in MFRS; In PERS, if a venturer does not present consolidated financial statements (e.g. because it does not have a subsidiary), it applies the cost method or revaluation model in its financial statements, with the effects of equity accounting disclosed by way of notes. MFRS requires the equity method in the venturer s financial statements in such circumstance. The cost method or fair value model can only be applied in its separate financial statements; and MFRS requires disclosure of summarised financial information for each material joint venture and aggregated summarised information for all other immaterial joint ventures. There are no such requirements in PERS or MPERS. 3.2.5 Investments in Associates Both PERS and MFRS require the equity method to account for investments in associates, with some dissimilar exemptions and exceptions. MFRS requires an investment entity to measure investments in associates at fair value through profit or loss (mandatory), and for other mutual funds and venture capital entities that do not meet the definition of an investment entity, the option of the fair value measurement remains available (non-mandatory). There is no such exception or exemption in PERS. On the other hand, PERS does not permit equity accounting for temporary investments or when an associate operates under conditions of severe restrictions. These two exceptions have been removed in MPERS and MFRS. MPERS provides the greatest flexibility in the accounting for investments in associates. An investor chooses, as an accounting policy, to account for the investments in associates using: (a) the cost model, (b) the equity method, or (c) the fair value model. Furthermore, consistency in measurement is not required because an entity using the cost model for investments in associates must apply the fair value model for any associates that are quoted. Similarly, an entity using the fair value model for investments in associates must apply the cost model for any associates for which it is impracticable to measure fair value reliably without undue cost or effort. This flexibility effectively renders the exemptions or exceptions in PERS and MFRS redundant, because the reporting entity, whether it is an investment-type entity or otherwise, can choose a measurement model that best suits its requirements. The other differences in accounting treatments include: (a) Remeasurement requirements of the remaining stake when there is a loss of significant influence in both MPERS and MFRS, but they are not exactly the same. When an associate becomes a joint venture a remeasurement is required in MPERS but not in MFRS because the equity method continues to apply in MFRS, whereas in MPERS this may not be the case if the investor had previously applied the cost method. Also, MPERS does not allow a remeasurement of the stake retained if the loss of significant influence is other than by a 8

(b) (c) (d) (e) (f) partial disposal whereas MFRS does not have this restriction. There is no remeasurement requirement in PERS, which means that the stake retained shall be measured at the equityaccounted carrying amount at the date significant influence is lost; MFRS requires reclassification adjustments of OCI reserves to profit or loss when significant influence is lost but there is no similar requirement in PERS and MPERS; If an investor does not issue consolidated financial statements (e.g. because it does not have a subsidiary), PERS requires that the investments in associates be accounted for under the cost method or the revaluation model. The effects of equity accounting are disclosed by way of notes. MFRS requires the equity method in the investor s financial statements in such circumstance. The use of the cost method or fair value method is applicable only in the separate financial statements, which are non-mandatory statements in the MFRS. PERS has a provision for reciprocal shareholdings that requires an investor to disregard the associate s ownership interest in the investor when the investor applies the equity method to avoid double-counting of results. There is no similar requirement in MPERS or MFRS. PERS requires an investor to account for all net asset changes in the associate, including those arising from issuance of shares by the associate to other parties or to settle employee share-based payment arrangements. This means that the investor takes its share of profits and losses through profit or loss and its share of other equity movements (e.g. share option reserve) through equity. These other net assets changes are not dealt with in the MFRS (The IASB had earlier attempted to address this issue in an ED to propose a similar requirement, but in May 2014 that proposal was withdrawn due to insufficient support from Board members). MFRS requires disclosure of summarised financial information for each material associate. All other immaterial associates are aggregated for disclosure of less detailed financial information. There are no such requirements in PERS and MPERS. 3.2.6 Foreign Currency Transactions and Operations PERS uses the concept of reporting currency for translation of foreign currency transactions and operations, whereas MPERS and MFRS both use the concept of functional currency for measuring the results and financial position, and the presentation currency for presentation of financial statements. These are fundamentally different concepts because the starting point in the application of this area in MPERS or MFRS is for an entity to identify its functional currency (a currency of the primary economic environment in which it operates) for measurement purposes. The functional currency is not necessarily the local currency. For translation of foreign currency transactions, PERS differs with MPERS and MFRS in many treatments and these include: (i) the use of contracted or forward rate for an unsettled monetary item that has a related matching forward contract, (ii) hedging of net investment in a foreign entity, (ii) allowing exchange difference arising on a recent acquisition of an asset to be included in the carrying amount of the asset if there is no practical means of hedging, and (ii) a choice of treating goodwill and fair value adjustments as assets and liabilities of the foreign entity and translated at closing rate or as assets and liabilities of the reporting entity and translated at the historical rate. Both MPERS and MFRS do not have these exceptions and they require goodwill and fair value adjustments must be treated as assets and liabilities of the foreign operation and translated at the closing rate. 9

In PERS, two mutually exclusive translation methods are prescribed depending on whether the foreign operation is an integral operation or is a foreign entity. Under the functional currency concept used in MPERS and MFRS, there is only one classification of foreign operations because an integral operation in PERS would automatically have the same functional currency of the reporting entity. Hence, only one translation method i.e. the closing rate method is prescribed for foreign operations. Note that if a foreign operation keeps its accounting records in a local currency which is not its functional currency, a re-measurement is required to provide the same results and financial position if they had been measured using the functional currency. On disposal of a foreign entity, PERS requires the cumulative exchange reserve related to that foreign entity must be recycled to profit of loss. In the case of a partial disposal, only the proportionate share of the related cumulative exchange reserve is recycled. MFRS has a similar requirement for recycling of the cumulative exchange reserve, except that the amount recycled is the entire amount of the cumulative exchange reserve (excluding any NCI s portion) when there is a loss of control, loss of joint control or loss of significant influence, regardless of whether there is any equity stake retained. Any equity stake retained would then have a fresh-start remeasurement at fair value. MPERS specifically prohibits recycling of the cumulative exchange reserve on disposal of a foreign operation. 3.3 Financial Instruments 3.3.1 Recognition, Measurement and Hedge Accounting This is a major area of differences between PERS and MPERS simply because there is no equivalent MASB Standard on the recognition and measurement of financial assets and financial liabilities. IAS 25 Accounting for Investments, which is endorsed as a PERS, classifies investments into current and non-current investments, and there are numerous measurement models prescribed. Derivative instruments are off-balance sheet i.e. unrecognised until settlement. The MPERS covers this area in two sections i.e. Section 11 for basic financial instruments and Section 12 for other financial instrument issues, with an option for private entities to apply the recognition and measurement requirements of MFRS 139. For a private entity that has no complex financial instruments, it only needs to apply Section 11 of MPERS and the accounting requirements have been simplified. The principles of recognition, derecognition and measurement prescribed in MPERS for basic financial instruments are generally the same as those in MFRS 139. However, MPERS is a simplified version in that it does not contain rigid or rule-based classification requirements. Basic financial instruments are cash, debt instruments (receivables and payables, including inter-company receivables and payables), commitments on loans and investments in straight ordinary or preference shares. Intention of management, such as whether an instrument is to be held for trading or held to maturity, is not a criterion in the classification. This is a primary criterion in MFRS 139. In MPERS, generally all basic financial instruments shall be measured at cost or amortised cost model (with one exception). These include debt instruments, such as investments in quoted bonds, regardless of management s intention and there is no option for fair value designation. For investments in straight ordinary or preference shares (or similar equity investments), they must be measured at fair value through profit or loss but only if there is a traded price or the fair value can otherwise be measured reliably. The complex requirements of available-for-sale assets and the tainting provision of heldto-maturity investments in MFRS 139 are not applicable to financial instruments of private entities. 10

The requirement for initial measurement has also been simplified in MPERS where the transaction price (i.e. the cost), which is an entry price, is used and there will be no gain or loss arising on initial recognition of a basic financial asset or a financial liability. However, if the arrangement constitutes a financing arrangement, such as an inter-company loan without interest, the entity measures the financial asset or financial liability at the present value of the future payments discounted at a market rate of interest for a similar risk-class instrument. MFRS requires the initial measurement to be at fair value for all financial instruments, which is an exit price, and there may be gain or loss arising on initial recognition. For impairment of financial assets, PERS requires that long-term investments must be written down for any decline in value that is other than temporary. This criterion is subjective, and in practice, private entities have relied on the condition of a permanent decline in value. For other financial assets, such as receivables, which are not covered in PERS, the current practice is based on management judgements in providing for specific and general allowances. MPERS and MFRS both use the incurred loss model based on objective evidence of trigger loss events, which means that an impairment test must be performed whenever there is any evidence of a loss event. For quoted available-for-sale investments, a significant or prolonged decline in market value is also an evidence of impairment. For receivables, individually significant receivables must be tested for individual impairment based on objective evidence, and for all other receivables, collective impairment is performed based on credit risk classes, analysed by past loss experiences of types of customers or types of businesses, areas of concentration and ageing of receivables. In the MFRS framework, embedded derivatives in host contracts must be assessed for separation, and if the derivatives are not closely related to their host contracts, they must be accounted for as a stand-alone derivative. The concept of embedded derivatives is not in the MPERS framework, which means that this complex requirement is not applicable for a private entity using MPERS. The MFRS framework has numerous prescriptive requirements, detailed application guidance and implementation guidance on the optional hedge accounting. The MPERS requirement is a simplified version of the MFRS hedge accounting model that is broadly similar in principles, but limits the application of hedge accounting to some basic financial risk exposures. 3.3.2 Presentation and Classification of Liabilities and Equity PERS does not have requirements on the classification of financial liabilities and equity instruments. For share capital and debt instruments, practices by private entities must comply with requirements in the Companies Act 1965 and its 9 th Schedule, and other regulations by Authorities. Substance over form is not a consideration for legal capital requirements. The requirements in MPERS are similar to those in the MFRS. Both apply the substance over form consideration to classify a financial instrument as liability or equity. Thus, an instrument that takes the legal form of capital but meets the substance of a liability (e.g. redeemable preference shares) must be classified as a financial liability. Conversely, an instrument that takes the legal form of debt but meets the substance of equity (e.g. a loan stock that represents residual interest) must be presented as equity. Both MPERS and MFRS require that the proceeds of a compound financial instrument (e.g. a convertible debt) must be allocated to liability and equity components respectively. However, MPERS version is simpler as it does not explicitly require a deferred tax liability arising on taxable 11

temporary difference when the proceeds are separated, whilst this is a mandatory requirement in MFRS. The other requirements on classification are broadly similar in the two reporting frameworks, although MPERS provides further guidance on the issue of shares, capitalisation or bonus issue and share splits. It also prescribes measurement requirements on the issue of shares, which generally should be by reference to the fair value of the cash, other assets or resources received or receivable. MFRS does not have this requirement and the measurement of shares issued in a transaction depends on the particular circumstances. When shares are issued in a business combination, both MFRS and MPERS require that the shares issued must be measured at their fair value rather than by reference to the fair value of the net assets received, and there may be a control premium in the consideration transferred. 3.3.3 Disclosures about Financial Instruments There is no equivalent PERS on the disclosures about financial instruments. MPERS disclosure requirements relate mainly to basic financial instruments, and for entities that have more complex instruments (including derivatives and hedge accounting) only limited additional disclosures are required. If, and only if, fair value is applied in the measurement of financial assets and financial liabilities the measurement basis should be disclosed, including where applicable, the valuation technique and the assumptions used. Compared with MFRS, MPERS does not require disclosure of the following information: (a) an entity s risk management objectives, policies and strategies, including hedging policies and strategies; (b) disclosure about market risks (currency risk, interest rate risk and price risk), credit risk, and liquidity risk; (c) the fair value measurement levels and transfers between levels; (d) the sensitivity analysis of variables used in the fair value measurement; (e) sensitivity analysis of market risks; and (f) disclosure about the quality of receivables, such as concentration of credit risk, ageing of receivables and impairment losses. MPERS disclosures about financial instruments are thus a simplified version catering mainly for small and medium-sized entities that typically do not have complex financial instruments. 3.4 Standards on Assets 3.4.1 Inventories For inventories, there are only minor differences between PERS and MPERS. PERS allows the LIFO formula for measuring the cost of inventories. This cost formula is disallowed in MPERS and MFRS. PERS provides for exempt entities not to comply with certain disclosure requirements of the Standard, but there is no such exemption in MPERS and MFRS. 3.4.2 Property, Plant and Equipment (PPE) PERS applies two recognition principles to account for PPE, one on initial recognition and the other on a subsequent expenditure if it enhances the asset beyond the originally assessed standard of performance. Mere replacements of components or parts of an item of PPE, regardless of the amount, must be expensed to profit or loss. Both MPERS and MFRS apply only one recognition 12

principle i.e. the principle of initial recognition by using a components approach to separately account for each significant component of an item of PPE. Consequently, any replacement must be recognised or capitalised as a new or a new component of an item of PPE. This means that the components or parts replaced must be derecognised. The measurement on initial recognition is the same for all the three reporting frameworks i.e. at cost. For the subsequent measurement, both PERS and MFRS, allow as an accounting policy choice by class of PPE, to measure PPE at the revaluation model. In contrast, MPERS only provides for the use of the cost model. There is no option for using the revaluation model or fair value model. 3.4.3 Intangible Assets PERS deals only with research and development (R&D) costs. The requirements are the same as MFRS in that only development costs that meet the specified recognition criteria are capitalised. MPERS makes a non-rebuttable presumption that for all R&D costs, the probability recognition criterion is not met. Hence, all R&D costs must be recognised as an expense when incurred unless they form part of the cost of another asset that meets the asset recognition criteria (for example, the cost of software development or an internal website development is added to a recognised operating system asset). PERS does not deal with other intangible assets, whether internally developed or acquired separately. In a business combination accounted for under the acquisition method, past practices were based on an old GAAP which required that an intangible asset is considered as identifiable only if it can be separated from the business as a whole (a separability criterion). Those that could not be sold separately from the business were subsumed in the resulting purchased goodwill. MPERS does not restrict the recognition of identifiable intangible assets acquired in a business combination to those that are separable. It considers the identifiability requirement met if an intangible asset is separable or if it arises from legal or contractual rights regardless of whether it is separable or not. MPERS assumes that the probability recognition criterion is always met for acquired intangible assets. It also makes a rebuttable presumption that the measurement reliability criterion is normally met for acquired intangible assets. The conditions for rebuttal are also prescribed in MPERS on business combinations and when rebutted the intangible assets are subsumed in the resulting purchased goodwill. MFRS has however moved on to presume (non-rebuttable) that both the probability recognition criterion and the measurement reliability criterion for intangible assets are always met in a business combination. Thus, all identifiable intangible assets in a business combination must be recognised separately from goodwill in MFRS, but this may not be the case for MPERS (because the measurement reliability criterion may be rebutted), and is unlikely for PERS (because the criterion of separability is unlikely to be met for most intellectual property). In MPERS, all recognised intangible assets are considered to have a finite useful life. Amortisation of an intangible asset is over its useful life, or if the useful life cannot be reliably estimated, the life is presumed to be 10 years. In MFRS, an intangible asset may have an indefinite life, in which case, there will be no amortisation of that intangible asset, but it must be subjected to annual impairment testing. 3.4.4 Investment Property (IP) 13

PERS has very limited guidance on IP accounting. The classification of land or building as IP is an all or nothing criterion of not substantially owner-occupied. This means that a property is classified as IP in its entirety if it is not substantially owner-occupied; otherwise it is classified as PPE. There is no threshold or bright-lines provided for this criterion. In contrast, MPERS and MFRS have no criterion of substantially owner-occupied and thus part of a building would be classified as an IP if it meets the definition. Similarly, an interest in an operating leased asset may qualify as an IP in MPERS and MFRS, such as when a lessee rents an entire shopping complex from its owner and sub-leases part of the complex to other tenants. In this case, the lessee may choose to treat the sub-lease arrangement as IP, being its interest in the underlying shopping complex. PERS provides a choice of classifying IP as a PPE or as a long-term investment. If classified as a PPE, the IP may be measured at cost less accumulated depreciation and impairment or at revalued amount less accumulated depreciation and impairment. If classified as a long-term investment, the choice of cost or revalued amount remains the same, except that the IP is not subject to systematic depreciation. MPERS applies a hierarchy of measurement in that if the fair value can be measured reliably without undue cost or effort, the IP must be measured at the fair value model. All other IP must be measured at the cost model. MPERS does not require a consistent accounting policy choice. In contrast, MFRS requires that the measurement model applied must be subjected to an accounting policy choice of either using the cost model or the fair value model. Although not explicitly stated, MFRS has a preference for the fair value model in its clarification that if an entity had applied the fair value model previously, it is highly unlikely that a change to the cost model would result in a better presentation. Disclosure of fair value information is also required if the cost model is applied. MPERS further provides that if an entity had previously applied the fair value model, and reliable fair value measurement becomes unavailable without undue cost or effort, the entity applies the cost model thereafter (not as a change in policy because it is a change in circumstances).this simplified treatment is not available in MFRS. MFRS however requires transfers from IP to inventories or to PPE and vice versa when there is change in the use of the property. 3.4.5 Non-current Assets Held for Sale and Discontinued Operations The term non-current assets held for sale is not in the PERS or MPERS literature. This means that there is no such classification for PERS and MPERS even if an entity has firmly committed to sell a non-current asset, a group of assets or a business. MFRS requires a separate classification and presentation of non-current assets held for sale, with the measurement being at the lower of carrying amount and fair value less costs to sell. Any impairment loss is recognised upfront even if the sale is not yet completed. PERS requires that if an entity is discontinuing an operation (business or geographical area of operations), the entity applies the relevant Standards to test for impairment of assets, recognise provisions attributable to that discontinuing operation, and provide disclosures of the effects in the financial statements. The disclosure of discontinuing operations is a line-by-line presentation of revenue and expense items using either a multiple-column format or a continuous format to distinguish results of continuing operations and discontinuing operations. In both MPERS and MFRS, the presentation of discontinued operations is a one-line presentation of post-tax gains and losses in profit or loss (and restatement of comparative) with the details disclosed by way of notes. 14